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Four Reasons to Prefer This China ETF Over FXI

The iShares FTSE China 25 Index Fund (NYSE: FXI) enjoys an enviable perch as the largest China-specific by assets. By virtue of its girth, the iShares FTSE China 25 Index Fund is also the most heavily traded China fund (average daily turnover of almost 13.6 million shares) and one of the largest country-specific ETFs tracking any market, developed or developing.

By virtue of those facts, FXI is viewed as the bellwether China fund. FXI is to China ETFs what Intel (NASDAQ: INTC) is to semiconductors and Coca-Cola (NYSE: KO) is to soda. Since it is the bellwether China ETF, FXI is also the China ETF most talked about in the mainstream financial press.

None of these things mean FXI is the best-performing China ETF. It is not and that fact has been duly documented. Investors looking to play the rebound in Chinese equities via large-cap should consider one of FXI's relatives, the iShares MSCI China Index Fund (NYSE: MCHI). Here are five reasons why.

Superior Performance
Critics could say the iShares MSCI China Index Fund is not that old and that its performance compared to FXI's could eventually decline. That is possible, but MCHI debuted in March 2011 and it is fair to say 20 months is a longer enough track record to make some valid comparisons.

When accounting for paid dividends, MCHI has outpaced FXI by over 400 basis points in the past 12 months. MCHI has accomplished that with volatility of 23.6 percent compared to FXI's volatility of 25.9 percent. Over the past three months and six months, MCHI is the better performer as well and that those gains have also accrued with lower volatility. One reason for MCHI's superior returns might just be...

Lower Fees
A dissertation is not needed for this subject. Simply put, FXI charges 0.72 percent per year. MCHI charges 0.58 percent. Translation: $10,000 invested in equals $72 in fees. The same amount invested in MCHI equals $58 in fees. That gap might be meaningless to active traders, but investors with a long-term outlook on China cannot afford to overlook the cost savings associated with MCHI.

Tracking Error
Speaking of expenses, tracking error is part of the total expense equation with ETFs. Simply put, tracking error is the margin by which an ETF deviates from its underlying index. There is no such thing as an ETF with no tracking error, but some are more adept than others at mitigating this issue.

Both FXI and MCHI deserve credit on this front. According to iShares data, FXI has an annualized tracking error of 0.68 percent. That beats its expense ratio of 0.72 percent. Any ETF where the tracking error is below its expense ratio deserves some praise.

MCHI's annualized tracking error is 0.55 percent, meaning its tracking spread relative to its expense ratio is smaller than FXI's (three basis points compared to four). That does not change the fact that MCHI's tracking error is lower.

Diversification
A common criticism of FXI is that it is home to just 26 stocks. Twenty-six stocks is hardly reflective of the Chinese economy, the world's second-largest. MCHI is home to 142 stocks. MCHI's top-10 holdings represent just under 53 percent of the ETF's weight while FXI's top-10 names equal 61.2 percent of that ETF's weight.

Financial services names loom large in both ETFs, but MCHI's 37.4 percent allocation to the sector is preferable to FXI's 57.1 percent concentration to that group.